Why we should be worried about Australia’s housing market

The RBA’s rate cuts have gone too far. And if they stay this low for too long, there is a real chance Australia could, belatedly, have its own acute housing crash with real economic consequences. Photo: Glenn Hunt

Christopher Joye

I am worried about Australia’s housing market. Very worried. Not so much about the fundamentals, which are solid. Or current performance, which is robust without raising alarm. I am concerned about what lies around the corner – and here, I am talking months, not years.

I presented at a hedge fund conference during the week with notorious housing pessimist Gerard Minack. There was a fascinating role reversal. Asked about Australia’s housing prospects, Minack said he now buys into the view that house prices will track incomes.

Minack was up front in admitting that he forecast striking price falls during the global financial crisis – he certainly bandied around figures in the 20 per cent range. He explained that he was wrong because it was “garbage in and garbage out”. The enormous rise in the jobless rate he anticipated never materialised.

This has been a maxim I’ve advocated for years. I’ve regularly demonstrated that domestic housing costs have tracked, or slightly under-clubbed, disposable household income growth since 2003. That’s comforting and what should happen through a cycle. Amid forecasts of catastrophic gloom in 2008 and again in 2011, I attracted criticism for publishing more reassuring views. Price depreciation was likely to be modest, I argued. And if the Reserve Bank of Australia cut rates, the elasticity of our interest rate sensitive housing market would surprise on the upside. This was close to what transpired.

RBA cuts have gone too far

But I no longer think the situation is so benign. The RBA’s rate cuts have gone too far. And if they stay this low for too long, there is a real chance Australia could, belatedly, have an acute housing crash with real consequences for the economy.

While this is not my current central case, several factors give me pause.

The first is that households have not really deleveraged despite much spruiking about our “cautious consumers”. Australia’s elevated household debt-to-income ratio, which looks set to climb further, is not far off the all-time, pre-GFC peak.

This highly leveraged consumer is an artefact of Australia’s even more leveraged banking system. The major banks are leveraged about 80 times across their $1 trillion home loan books. Put differently, they are only holding about $1.25 of true loss-absorbing capital against every $100 – as opposed to the “risk-weighted” value – of their assets.While banks do not “mark to market” their mortgage books with current prices because they account for them on a “hold to maturity” basis, with such extreme leverage you only need a small drop in asset values to make the banking system theoretically insolvent (assuming market prices).

A third issue is that the banking system is under tremendous pressure to maintain its internationally lofty returns on equity.

Although default rates are modest, APRA has discovered a worrying rise in the share of home loans approved with risky loan-to-property value ratios.

Home loans with LVRs greater than 80 per cent

A stunning 33 per cent of new home loans are today being advanced with LVRs greater than 80 per cent. In some countries they don’t even allow banks to lend at these levels, period.

Of course, since the RBA has taken the easy option of slashing borrowing costs to their cheapest levels in history, consumers are being given every incentive to gear back up.

My fear is that the longer rates remain at all-time lows, the greater the likelihood borrowers will believe that this is some sort of “new normal”. That they will extrapolate out from the recent past to the future.

The complacency is compounded by the fact that Australians have not experienced a recession in 22 years. Most have never endured a bona fide housing rout either. The reflex is to think that policy makers will always be there to diversify away downturns.

The reality, however, is that these same officials have exhausted most of our monetary and fiscal ammunition in the name of avoiding what is likely some natural business-cycle volatility as the growth pulse migrates from investment to production.

A related anxiety is that the RBA will confront deep resistance to properly normalising rates to the extent required to avoid these imbalances. The risk is that RBA officials talk about accommodating a bout of asset and consumer price inflation because they want to maintain “full employment”.

They push a so-called “dual mandate” to jobs and inflation despite the inherent short-term conflicts between these goals. One new RBA board member even calls herself a “growth girl”.

Housing supply challenge

A final concern is Australia’s housing supply challenge. We do need to build many more homes to accommodate the circa 15 million additional residents that will live here within 35 years.

Developers do require positive price signals to commit scarce capital to constructing new supply.If our mounting supply-side deficiencies are allowed to accumulate we could see an even more exaggerated housing market cycle.

So APRA, the RBA, and their political masters have to work early and actively together to resist the financial system’s innate desire to promote higher indebtedness.

This will necessitate courage given the over-the-horizon perspective on which it is based, and the array of commercial interests allied against such parsimony.

The Australian Financial Review

BY Christopher Joye

Christopher Joye is a contributing editor to The Australian Financial Review. He is a leading economist, fund manager and policy adviser who has previously worked for Goldman Sachs and the RBA, and was a director of the Menzies Research Centre. He is currently a director of Smarter Money Investments.

BY Christopher Joye

Christopher Joye is a contributing editor to The Australian Financial Review. He is a leading economist, fund manager and policy adviser who has previously worked for Goldman Sachs and the RBA, and was a director of the Menzies Research Centre. He is currently a director of Smarter Money Investments.